Short Term, Olympics Might Do Brazil Economy More Harm Than Good

Shoppers browse merchandise during the opening of Brazil's Cocacabana Olympic megastore in Rio De Janeiro, Brazil, on Thursday, June 30, 2016. Olympics seen pushing inflation higher and postponing near-term rally in interest rates. Equities would suffer if October rate hike panned by Central Bank. (Photo by Dado Galdieri/Bloomberg)

A few things are hard to imagine about Brazil right now. One is that the Olympics in Rio can possibly be anything but horrible judging by the headlines. The other, from an investors point of view, how Brazilian stocks can possibly go any higher? Brazil's large and small-cap stocks as measured by the iShares Brazil (EWZ) and Market Vectors Brazil (
BRF) exchange traded funds are up over 63% while the benchmark emerging markets index is up a measly 12.5% year-to-date ending Thursday. Is it too late to jump in? Are these things in for a fall?

Maybe. If the Olympics bring on more inflation, then the market will watch rate cuts being priced out until the first quarter of next year instead of the fourth quarter this year. That could pull the rug out, for now.

Opening ceremonies of the Rio 2016 Olympics begin tomorrow night. Following months of trash-talk and zika virus scares, Rio will be on full display. As Americans tune in to watch Hope Solo and the women's soccer team, investors will be tuning in to what the Olympics will mean to the economy. Did tickets to the games sell out? Were hotels as booked as expected? Did Olympic projects get done in time and if not, what is the likelihood of them getting done at all? Are Olympic fans buying T-shirts and drinking a lot of Brahma beer? The World Cup did little to the move the needle on AmBev, Brazil's biggest beer maker.

Nearly 8 years ago, when the Olympics were first sold to the country by its politicians, Latin America's first ever summer games were seen as heralding an era of modernity. It was important for Rio. The iconic home to the bossa nova is a city where the fight against poverty and crime seems to have one winner: poverty..and crime. Rio didn't suddenly get worse. But the Olympics haven't really made it all that much better, some people say.

Outside of Rio, what will the Olympics bring for the Brazilian economy?

How about...more inflation!

Brazilian soldiers patrol outside the Olympic Village ahead of the 2016 Summer Olympics in Rio de Janeiro, Brazil on Thursday Aug. 4, 2016. Between zika scares, dirty water and security issues, the Brazilian Olympics have been deemed a failure before they even started. And now some economists think the Olympics could cause short term economic pain, too. (AP Photo/Gregorio Borgia)

According to Euler Hermes, the world’s leading provider of trade credit insurance, a 0.4% inflation increase is likely from the Olympics alone. They are also forecasting a 5% increase in Rio de Janeiro-based companies filing for bankruptcy protection and a 12% increase in small business loan defaults.

Most of this, however, probably has as much to do with the bursting of the commodity bubble a few years back and the government's talent at shooting itself in the foot.

A decade-old corruption scandal surrounding oil firm
Petrobras is likely to cost president Dilma Rousseff her political career when she faces a Senate impeachment trial in three weeks. It shut down a lot of government infrastructure projects and forced the new interim government to cut back on state bank lending in housing and big development.

Increased investment projects and tourism linked to the Olympics will add only 0.05 percentage points in real growth to Brazil’s GDP, according to the Euler Hermes report. Consensus estimates have Brazil's GDP declining 3.5% in 2016.

Total Olympics infrastructure investment between 2009-2015 reached around R$38.5 billion ($12 billion), a small sum compared to the country's $2.2 trillion economy. Tourism is expected to generate R$1.3 billion ($400 million) and increase real growth by just 0.02 percentage points – less than half amount originally estimated.

“The increases in jobs and tourism (from the Olympics) look good on the surface, (but) they are just not enough to offset the severe economic turmoil that has plagued Brazil since before the Olympics. Inflation could even be significantly exacerbated by the Games,” said Daniela Ordonez, Latin American economist for Euler Hermes. Infrastructure investment and public spending increased Rio de Janeiro’s debt by 17%. The state received a federal government bailout in June.

During the investment phase leading up to the Olympic Games, the number of new companies surged, especially for micro and small enterprises, Ordonez points out. The massing of new businesses in relatively few sectors will generate a “crowding out effect” between newcomers and fragile existing companies unfit to benefit from the games.

Most of these players will be privately held enterprises. But defaults will stress banks and damper investor sentiment at the margin.

“Brazil is unfortunately not in a position at this time to benefit from the potential positive impact the Olympic Games can have on a host country’s economy,” Ordonez says in a press release. “Instead, the timing of hosting the World Cup and Olympics back-to-back has had an increasingly negative impact. With everything else the country is currently experiencing, Brazil’s economy did not need more drama right now.”

Ordonez's view is more contrarian than most.

Brazil could become a sleeping giant after the Olympics and impeachment process end this month. Once those two events have passed, Brazil headlines will seem mundane and are likely to focus more on economic recovery. Meanwhile, any pullback in Brazil will probably bring on investors. Providing the U.S. remains dovish on interest rates and China demand for imports holds up, emerging markets are expected to do well. Brazil, which has been beaten up for so long, might have room to grow. As it stands, GDP forecasts for next year are finally positive. In Brazil, 0.5% is practically an economic boom.